Sunday, November 7, 2010

How the 2008 Sub-Prime Crisis Happened?

The 2008 credit crisis that originated in the U.S.A. resulted in the Great Recession. Even till today, the US economy is still sluggish despite two massive stimulus package from the Federal Reserves.

So how did the credit crisis happened? Today, even if you go to Shenton Way and ask the bankers, most of them will probably not be able to explain how the sub-prime bubble burst.

Therefore, I hope to educate and enlighten my readers on the 2008 "Sub-prime Crisis" in the US.

The video below is an excellent illustration of the crisis. (The graphics and animations are fantastic! >_<)

The "Crisis of Credit" video is owned by Jonathan Jarvis.

Allow me to break down the story/ events:1. Between 2004 and 2007, American banks started to lend money to people who do not have healthy financial status. The type of mortgages were called "Sub-Prime Mortgages" because they are "sub-standard". I am going to call these homeowners the "Cannot-make-it-homeowners". (Way to go.......greedy American banks -__- " )2. The banks then re-package these sub-prime mortgages into investment-grade (AAA rated) instruments called "Credit Default Swaps" or CDOs. The global giant insurance company AIG went really deep into these CDOs. Millions of CDOs were sold to retail and institutional investors. (Our very own DBS and various Town Councils bought alot too.....sighz -__- " )3. Everything was fine at first. The homeowners were paying their loans, the investors are getting their returns and the bankers earned huge salaries.4. However, the nightmare scenario occurred. The "Cannot-make-it-homeowners" could not pay their mortgages. The investors lost a huge amount of their fortunes and the banks (Lehman Brothers) collapsed. 5. In the end, banks stop lending money to one another and to other businesses. The global credit crisis began.

My Thoughts and Reflections:

I personally feel that the ultimate cause of all these unfortunate series of events is "Human Greed". The banks were greedy. The homeowners were greedy. The investors were greedy. The insurance companies were greedy. The ratings agencies were greedy. The lawyers were greedy. Everyone wanted a piece of the pie, and the bigger the better. In the end, everyone over-leveraged and the bubble burst. I will always use this crisis to remind myself not to be greedy and over-leverage my investment. I have resisted the temptations of getting a credit card many times. Some of my peers even said, "How can you not have a credit card?!!!!"Sighz........

Anyway, is greed really good for us? Will such a crisis happened again? Will we learn our lesson? How do you prepare your portfolio for such crisis?Let me know your views by posting below.

It began way back in 2000 when the Fed does not want the dot.com bubble to burst. Without the ultra cheap money (Greenspan lowered interest rate to 1%), people won't be able to gamble with that money. All those money has to go somewhere and it goes to the property market.

The govt created entities like Fannie and Freddie to guarantee mortgages. The govt also guarantees bank deposit insurance. This creates a moral hazard. No one bothers about what the bank is doing with the money. THey are guaranteed by the govt anyway.

In a free market, this would not have happened. It's because of this moral hazard that people dont pay attention. Think about it, today people spend more time researching on the camera that they want to buy than researching on the soundness of a bank to deposit their cash. In fact, I think most people do not do any research on banks at all.

Greed is not the cause of the crisis. In free market capitalism, greed is balanced by fear. Unfortunately, the govt has removed fear with all those guarantees.

It is amazing to view this whole housing bubble in hindsight. When their is a feeling of euphoria and excitement in the air about something everybody gets caught up in it. Nobody in the bubble believes it will ever end but it will' This over confidence than causes the bubble to get bigger and bigger all the time until it bursts of its own weight.